8. Practical aspects of the handling of inventories

Chapter 8



by: josavere

The theoreticians in this matter present a model to minimize the cost of handling of inventories and to calculate the optimal order that only has application in exceptional cases.

Q: amount of order (large economic batch)
V: annual sales C: cost per unit
Cp: cost of placing an order
K: cost of unit cost maintenance of the inventory, as a % of the total of the


The model bases the calculation on the cost of a unit and the value of placing an order.
In storage, even though it is contracted with third parties, two possibilities exist: the first, that the warehouses are own, in which case the industrialist incur in the cost of opportunity plus the maintenance costs or renting of the warehouse.
The heading acquires characteristics of fixed and consequently it loses his variability in relation to the units that are stored. The same thing happens to the value of processing an order. The theoreticians speak of the cost of the paperwork plus the time it takes to process the order. Who can measure the cost of ink when it is placing an order? How much cost the paper?
In the immense majority of the cases, the order is studied in different centers from which indeed it is placed, with the common characteristic that both, employees or executives have fixed assignments and, the time of processing an order is not measurable, with the methods developed by Industrial Engineering. 

In addition to the previous considerations, the model assumes requirements that do not appear commonly:

  • The supplier is permanently expecting to dispatch immediately.
  • The products are homogeneous.
  • The production and demands are constant.
  • Restrictions in when it does not exist to conditions of suppliers.
  • The qualitative aspects do not influence it for anything. It is assumed that the economy is stable. 
And the model assumed, in the case of imported merchandise, that the governmental organizations are very diligent to transact the import licenses and in the ports there are very honest and efficient people working; that the trucks are always available awaiting to be unloaded, etc. 

The previous considerations are sufficiently explicit to illustrate the initial affirmation. The handling of inventories is not a problem that can be solved by means of a mathematical formula, although the generally used indicators contribute to an efficient administration.
A measurement very used in financial analyses is the rotation of inventories to measure the efficiency in the administration of these assets, which are calculated according to the formula:

Ir: rotation of inventories
CMV: cost of the merchandise sold
Ii: initial inventory
If: final inventory

Previous function: Ir = CMV / [(Ii + If )/2] = times.

In addition to the limitations of the financial analysis, it is important to bring the famous phrase:” statistical is the science that if you have eaten a chicken and I have not eaten anything, on average each one would have eaten half a chicken.”

According to the law of the big numbers, the series of data tend to concentrate around a value or measurement of central tendency that is the measurement of rotation of inventories.

Using a frequency distribution of short periods (months) and used the suitable measurement (the fashion, medium, or the average arithmetic) the problem is that ignoring the dispersion measures. It is very probable that in the inventories we find a series of products of highest rotation; some of the average rotation and others of slow rotation.

The law of Pareto talks about efforts for 20% to handle 80% of products and vice verse. What at first look like sight "genius" advice, is that products are left aside and concentrate the activities in others. This common affirmation, obeys to the purely mathematical analysis, the merely cold calculation.

The great superiority of men over machines is exactly in the qualitative analysis or of criterion, what it is not possible to be exposed numerically. It corresponds to the management calculate indices for similar groups looking for the indicator that provides information to us adapted for efficient handling. 


Is good complementing the mathematical models with the method of trial and error We go step by step:
A. INDUSTRIAL COMPANIES: in this sector is necessary to analyze four types of inventories: raw materials, finished products, in-process and spare parts.

a. Finished product: if the company properly prepares a plan of value generation, it is easy to determine for the different times of the year the levels of finished product inventory, in accordance with the estimation of the demand. Arithmetically it is:

If: final inventory (budgeted).
If: final inventory (budgeted) Ii: initial inventory.
Pp: programmed production.
Ve: projected sales. 

The periodic control of the results with the budgets indicates if they are due to make a greater or smaller number of units in each type, depending on the success that has been obtained when projecting the sales.

The analysis of the characteristics of the product is very recommendable (in case they are perishable, volatile, etc.) and the relations with the suppliers. 

That way we have an element of control and analysis. The periodic revision obeys to a master plan that contemplates the projection of cash flow, the seasonality of the sales, the elasticity of the production, and the flexibility of the company to adapt to the changes that appear during the exercise. The feedback will set the standards to take the pertinent measures.

b. Products in process: using the great advances of industrial engineering, after a conscientious study of methods of work and distribution of the plant, it comes to the measurement of the time of processing.

The optimal amount of units in production is a function of the time of the process, the capacity of the plant, the prognosis of sales, and the number of finished products that are defined as political considering the qualitative aspects.

One recommends special care of the wastes, investigating its causes and taking the remedial actions and reporting it in the state of results.

c. Raw materials: each company should proceed to determine a level of minimum stock as a safety margin, sum to which the amounts will be added to the order, based on the following variables:

  • Amount of units to produce
  • Standard consumption by each unit to produce.
  • The origin of the product (if it is imported, if it is domestic or if it comes from some region different from the location of the plant)
  • Available facilities at a given moment, by another one of similar characteristics.
  • Commercial relations with the supplier.
  • Transportation facilities.
  • Minimum conditions of the supplier (demands as far as minimum orders).

It corresponds to the managing of the storing of raw materials, to determine in accordance with the acquired experience, the safety margins and to process periodic orders, consulting the eventual corrections that are made to the production program.

d. Spare parts: for whose handling all the previous considerations are useful and you specify them according to the types of products.

B. COMMERCIAL COMPANIES: for the companies of this type of handling of the inventories it constitutes altogether with the portfolio, the spinal cord of the managing of the business.

In this type of company, the suitable management of the working capital guarantees optimal results. Among the retailers, an affirmation is very common according to which the business becomes by means of the purchase procedure. In the world of the businesses lives a permanent disloyalty for the consumer’s money. The experts in marketing teach that consumer is by its changing nature; sometimes rational, other touching and in certain cases sufficiently analytical, etc.

Beginning from a key concept, according to which to predict the behavior of the consumer is a very complex problem and that depends on a great number of variables as the individual behaviors, the buying power, the economic perspective, and other variables as much as of macro as the micro-economic type which they properly do not constitute the object of this article, we concluded that:

  • The combination of this great amount of so divergent variables is the one that really induce to the purchase decision.
  • Predicting the right behavior constitutes the main challenge of the retailer.  But, as they also say, that it does not obey a mathematical model, but rather to the "sense of smell" or what could be called "commercial ability", in some cases innate and in others acquired based on experience.
  • It is specially intended to predict a demand, to make the purchase in the best conditions considering the previously mentioned variables, and to verify the success in the prediction. The retailer constantly comes repeating operations of this type. It is a constant handling of risks versus profanity expectations. From the practical point of view, very little has advanced in the measurement of the risk, we can neither offer a formula.
  • We again return to invoke a golden rule in the businesses: 
PRUDENCE AND GOOD CRITERION: when there is no previous
knowledge of the article for how much it represents true innovation, it will be called on to the industrialist to consider the amount of money that could be frozen or be lost in the event of wrong guessing, without the company suffering an impact in its liquidity, because we always must have as a basic premise, the opportune payment to the suppliers not forgetting that in general terms, the obtaining of a discount by onetime payment constitutes a great investment.


C. AGGRO-INDUSTRIAL COMPANIES: in this sector, it is fulfilled in greater proportion with the considerations previously done, and consequently, the use of the criterion and the experience which, are constituted indefinite elements to handle controllable or uncontrollable variables according to the case. It is very useful for the economic use of the statistical techniques and projections according to updated information as harvests, shortage, a period of production, etc. 


In the administration of inventories because of the so-called method of trial and mistake, the detailed and wide accumulation of statistics that record the experiences acquired through time is constituted in a basic and irreplaceable element as help in the decision-making process. Each company will have to design its own models and to complement them with the notes that it considers pertinent to have of elements judgment which facilitate the decision making. 
For example it would be possible to be prepared: the monthly sales discriminated
by lines of products, by geographic sectors, salesmen; notes on advertising campaigns, change of price, sales offers, production per hectares; fertilizer ranges per/m²; number of bushels per block, etc.
With the accumulation of data and the use of the technique of the inference
statistical (prediction) the measurement of elasticity of the demand in relation to the different variables can be tried, as the price and the publicity, indicators of correlation; models of regression, etc. providing elements of judgment as an important support to measure the results of the decisions to be made, and to try to predict the behavior of the demand, that as we said previously, constitutes the variable key for the management of inventories. 


The concept of responsibility centers is very useful. Zoning of the different types of inventories are recommended in such a way that for all products, a person in charge and responsible for the amount in stock loses by theft and deterioration and for their conservation and handling of the products.

The distribution by areas obeys to measurable rules from the point of view of industrial engineering, that is to say, they do not respond to the operational control.

Consequently, it should be done based on the administrative control, considering among others the following variables:

  • Amount of orders/days.
  • Easiness of manipulation, according to the packing, weight, and specific conditions.
  • Physical distribution of the warehouses.
  • Necessity of special care to avoid deterioration.
  • Product homogeneity to a group in an area.
The ones in charge of each area have the responsibility to handle it as if it was their own business, because they are responsible for it. It will be his commitment to warn when the product arrives at the indicated level is replaced for they must take care of the case, the requirements by computer or roll o decks cards.

Also, they must be responsible for a suitable manipulation to maintain the goods in optimal conditions and to be responsible for any loss that happens. The salesmen must prepare the orders by areas; and the director of purchases will come in the same way, entering the information of the inventor is a codification in accordance e with the requirements for each business.

By the accumulation of experiences, the company can distribute inequitable form the different centers, with the object of maintaining the personnel occupied, with balanced loads. As example areas in a commercial company it can be insinuated: 

Area 1: Footwear
Area 2: Household-electric
Area 3: Ironworks Articles and other
Area 4: Toy store
Area 5: Articles for the home
Area 6: Preparations  


The accounting presents many methods of costs, among the most important there are:

A. FIFO: according to which, the first units entering the inventory, will be the first in leaving. According to this method the materials that are being used pay for the oldest price of acquisition increasing the contribution margin.

B. LIFO: last in entering, first out. The used materials are loaded on to the most recent price, reducing the profit margin.

C. COST AVERAGE: the average calculates a value, that is to say, the units are paid for base on the arithmetic average of the prices of acquisition.

D. NEPS: next in entering, first in leaving; it is equivalent to a value of replacement; in other words, the price to replace it.

E. SPECIFIED COST: as the case of the cars or businesses of real estate.

Note: as far as possible to the value of the raw materials the handling cost is due to be added until its location in plant (loads, insurances, transport, etc.)

If it must pay a superior tax to the one recognized by the government, this greater value must be added to the material; if the expenses are not perfectly identifiable they enter as indirect expenses of manufacture.

For industrial companies, it is possible to be used costing by absorption or direct costing. The basic difference between both methods is based on the processing of fixed the indirect costs of manufacture, renting, administration, etc.

Direct costing assumes that these costs appear based on time and consequently they are not accumulated as a greater value of the produced units. This way the units paid for by the absorption method is overvalued in relation to costs by direct system.

Let us remember that if in a period of time the produced and sold units are equal, the earnings statements are identical by both methods of costing and that direct costing is especially recommendable for purely administrative effects and specific businesses, especially when the plant capacity has not been reached. The combination of both methods is very recommendable form an agreement.

Each company will use the system of costing as more recommendable for its specific situation, considering the advantages and disadvantages to each one of the methods enunciated previously.

For control effects, the periodic processing of physical inventories is indispensable to confront with the standard firing dates and to take the appropriate actions, as much managerial (identifying the people in charge) as accountable.

If the losses appear by managing faults they are considered a cost; if by inherent causes to the product or the process, on costs of the product, and in the other cases, they can be treated as indirect expenses of manufacture. 


With the extraordinary advance of the technology of the computers, among others, specific models of handling of inventories have been developed, which ease up the accumulation of statistics by the great capacity of information storage, the key variable in the use of experiences. Equally important, is the great facility of consultation, using the different measures from the exit of information, besides offering basic accuracy and promptness, elements for the decision making. The companies use software for control of inventories. This one begins with an account of inventories in its memory; these programs only work feeding them with:
  • Physical inventory
  • Purchases
  • Price of purchase per article (code)
  • Sale price per article (code)
  • Percentage that is paid in taxes

As of a sale made, from the cash register properly connected to a terminal, it is recorded by the computer and it immediately makes the unloading of or articles.

The advantages of this kind of software offer are as follows:

  • It permits an immediate and updated knowledge of the inventory.
  • It reduces considerably the costs of the handling of the inventory.
  • When the nonsingular sale is made the unloading is also made not only on the accounting but also in the inventory making it more agile and efficient.
  • It establishes very important statistics for the making of decisions, as for example the average of the purchases, the price average, the percentage in which the prices of purchase varies, etc.
  • When one has handled these systems, by a year or more it allows to create statistics that inform on the periods in which there is a greater rotation of inventories, which kind of articles are sold in greater number at different times, which tendency do the prices have in certain product shortage, etc.
  • It allows creating standards of minimum and maximum inventory of each product individually, and an inventory average that is due to have at a certain time or period. This software, as it always maintains updated the inventory, has a very important option if a minimum level of each one of products paid attention; to at the moment at which it has arrived at the minimum amount of inventory of an article, it gives a warning so that an order is put in.

With respect to the advantages that this class of software offers, one is due to stand out that the exact and immediate information that the program offers, to make fast decisions. Let us remember when the company has greater and better information this in competitive advantage with respect to the other companies. For example, when paying attention to standards it can be anticipated ahead of time low inventories of certain products, or also the stagnation of certain kinds of goods in a period, easing up the decision making.

Takes advantage witch the information of the databases that throws software to know are the best periods for purchases, to determine the level of optimal inventory.

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